Quote of the Day

Western-style neoclassical economics was designed for settings where national institutions are already in place. In most of the world, they are not. The question is not "market vs. government," but how to strengthen the norms and institutions that will build both markets and governments at the same time and in the right directions.

Tyler Cowen tossed this off rather casually in a blog post about Latin America. I am supposed to give a talk on political economy in a couple months, and what Tyler wrote pretty much sums up what I plan to say.

Standard political economy uses what I call the "three-corner" model, with individuals, markets, and government as the main agents. Sweetwater economists see individuals as rational, markets as self-adjusting, and government as made up of self-interested individuals. Saltwater economists see individuals as impaired, markets as prone to fail, and government as a benevolent social optimizer.

What the three-corner model misses is exactly what Tyler talks about--the norms and institutions in which individuals, markets and government are embedded. Two comments to make about those:

1. Mutually beneficial trade among strangers depends on a fairly high level of moral and mental development. (Some people think that this point is made well in a book by Paul Seabright called The Company of Strangers. I was actually somewhat disappointed by the book, but perhaps it was because I was already a believer in the main thesis. So what seemed right about his ideas did not surprise me and what surprised me about his ideas did not seem right.)

2. One can observe a very large difference between what I call single-affiliation societies vs. multiple-affiliation societies. In a single-affiliation society, an individual's religious, political, social, and economic affiliations all fall within the same group--often a clan leader in a single village. In a multiple-affiliation society, your religious leaders differ from your political leaders, and both differ from your primary commercial contacts. You also have many other affiliations that connect you with an even wider circle of people. Single-affiliation societies are much farther away from having modern political and economic institutions than are multiple-affiliation societies.

Comments and Sharing

I don't know what is mean't by "neoclassical economics" in that statement, but economic freedom does seem to explain the economic divide between Chile (which now has the highest GDP per capita in Latin America) and the other Latin American countries.

It is true that most Latin American countries have a hard time collecting taxes, but it is their own fault because they effectively keep small corporations from forming through regulation, keep low paid laborers from legally working through strict labor laws, and have a lack of attention to the formalization and respect for real property rights.

Up until recently many Latin American countries could barely keep their currency worth more than the paper it was printed on. Macroeconomic stability is now slowly being achieved (except in Venezuela), but that is only the beginning.

There are plenty of anti-economy regulations that Latin American countries now need to tear down. Does a more pro-property rights culture need to happen for this to occur? Maybe.

I've read about the custom of 'cousin marriage' in certain parts of the world as being an exagerated form of single affiliation society. I wonder how correlated the phenomenon is with economic advancement?

I lived in the Middle East for a while and my experience there confirmed Arnold's thesis. There was very little in the way of honest business practices. Everyone considered cheating the other guy to be a sign of business acumen and they took great pride in doing it. As a result, transaction costs are very high. As much as possible, people enter into business arrangements only with family members, because cheating family is frowned upon. The costs of searching for quality products and services is very high if no family member sells it, because there are no money-back guarantees or return policies or any kind of protection against fraud. Foreigners are at a severe disadvantage because locals know most of the ways that people cheat and can protect themselves in some way. Sellers hold all the information and do their best to keep it from the buyer in order to cheat him as much as possible.

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